My first article and I immediately faced a dilemma. The ‘Topicality’ section was screaming at me, “ Sub-primes! You gotta write about sub-prime mortgages you moron, it’s the biggest story in town.” But the ‘Diary’ section made more sense, “ If you’re going to talk about trading foreign currencies for the next three weeks you’ve got to give people a chance. They’re comfortable with stock markets rising and falling and making a few quid trading RTZ, but what will they make of Cable, Loonies and Kiwi Yen? How about some helpful hints?”

This made a lot of sense. I think sub-prime mortgages will still be topical for a few weeks yet and trading currencies is a lot of fun once you get past the basics, so here we go:

If Carlsberg had been asked to come up with a market for spread betting it would have produced the forex market; massively liquid, tight dealing spreads, it lends itself to technical analysis and the major news events are announced publicly rather than nods and winks between well-paid City folk. You can get more leverage than a donor to the Labour Party, and for owls and insomniacs, it’s open 24 hours a day. All that’s missing is the Kylie look-alike turning up at your doorstep with a pizza and your winnings.

OK, that’s the spin, courtesy of one A. Campbell, now a word of warning, there are some very big fish in these waters and we’re the minnows. It doesn’t matter whether the big fish are clever or not as they’ve got the size to determine which way the waters flow. They may have misinterpreted Big Ben Bernanke’s comments, or missed the revisions to US payroll data, but they’ll determine the market direction long enough to stop you out. So, who are these big fish?

By far the biggest group are the speculators, or sharks (historically known as the ‘white sock brigade’). Their aim is straightforward, to whack it up, down or both so long as they make money. They can trade on technicals, economics, rumours or even 10 pints of Guinness just so long as they bring the profits in.

Then there are the hedgers, split into those who hedge investments and those who hedge commercial risk. An example of investment hedging would be a fund manager who wants exposure to the American market but not the dollar, so having bought the currency to pay for his investments he then sells it for settlement at some future date. Corporations (proper companies like Shell or Tate & Lyle) use the forex market to hedge exposure to future overseas payments.

The national central banks, like the Bank of Japan and the Peoples Bank of China are also occasional big players in the markets, their actions ranging from covertly targeting particular levels to issuing a very public message by visibly dealing in the currency markets.

Currencies differ from other investment markets in that you’re both buying and selling something at the same time. Currencies are quoted in pairs such as GBPUSD (Sterling/ Dollar) where the first quoted currency is known as the base currency and signifies the denomination of your trade. For example selling GBPUSD means that you are selling Sterling and at the same time buying US Dollars.

Prices are quoted in pips rather than tics or points and most main currencies are quoted to four decimal places (Japan is only quoted to 2 decimal places as it’s a massive figure already). So, carrying the example through if you sell GBPUSD at 1.9570 and it falls to 1.9520, that’s 50 smackers in the account. Easy isn’t it?

As usual there’s a bit of jargon, but nothing too frightening; firstly, currencies are loosely grouped into categories with names like ‘Majors’, ‘Minors’, ‘Exotics’ and ‘Scandies’. I won’t list them all else you’ll be switching over to You Tube to escape, but the majors are the US dollar (USD), Sterling (GBP), Euro (EUR), Japan (JPY), Swiss Franc, known as Swissie (CHF) and Australian, Canadian and New Zealand dollars (AUD, CAD, NZD) known as the Aussie, Loonie and Kiwi respectively. The other useful bit of jargon is that Sterling/ Dollar is referred to as ‘Cable’ as it was originally quoted by cable under the Atlantic.

Phew! OK, there’s the intro to forex markets; you deserve a caffeine break before I breeze through a couple of the dominating themes driving different currencies at the moment…

One of the key themes for some time has been the ‘carry trade’, which is an extension of the example in Z’s excellent piece on FX and interest rates. The extreme version is Japan, where interest rates are pretty much bugger-all, and New Zealand, where rates are over 8%. So, the bright idea has been to borrow from Japan at bugger-all % and put it on deposit in New Zealand at around 8%. This is known as the carry trade. Now, if you think of the ‘cake’ as being an interest rate difference of nearly plus 8%, the whopping great cherry on top is the fact that the New Zealand Dollars you bought when you sold Yen are also worth more, coz loads of people have been buying them. Wow! Thanks Santa.

The carry trade can be done with a lot of currency crosses. Not all traders fancy the Kiwi (New Zealand Dollar), but lots of them fancy borrowing Yen at bugger-all % and selling it into various currencies. Our very own British Pound has been a major beneficiary with interest rates of nearly 6%, as has the Euro, where rates are expected to rise further. So, most charts show the Yen going from bottom left to top right.

“Hold on, hold on. I thought you just said the Yen had been getting weaker. Now you say its rising!”

Oops, Sorry. Remember I said that when you deal in currencies you always buy and sell something? Well the price depends on which of the two currencies is quoted first. In most cases the Yen is the second quoted currency ($Yen, £Yen, Euro Yen), which means that 1 unit of the first currency will buy an amount of Yen equivalent to the rate. So, at a rate of 249.50, £1 would buy Yen 249.50. If the Yen keeps weakening then £1 will be able to buy more yen, so the price chart rises.

“ So traders are selling the Yen to buy a currency that pays a better rate of interest. But the US Dollar has been hitting record lows against loads of currencies and that pays around 5%. What’s that all about then?”

Ah yes, the gorilla in the living room. You know, the big embarrassing lump who doesn’t smell too good and who’s doing something pretty unpleasant with his thumb, but no-one wants to draw attention to him so they all pretend he’s not really there. The gorilla has been the US Trade Deficit for several years. For years Americans have been spending billions more of their dollars on goods from other countries than they’ve been receiving for selling their own goods. This massive imbalance has only survived because it suited certain Far-Eastern countries to have a lower currency, so they would sell their own currency, buying US Dollars. Every now and then the gorilla would draw attention to itself by complaining that these countries were controlling their currencies, before quickly sitting back down when he thought through the consequences. It became an annual ritual for economists to pronounce that the increasing trade imbalance and a strong Dollar were unsustainable- until just over a year ago when a little toddler said, “Look! There’s a gorilla in the room.”

Once people stopped pretending not to notice it they found plenty of reasons to sell:

• The US is slowing down.
• Oil producing countries are replacing their US Dollar reserves with Euros.
• China has started to allow its currency to rise against the Dollar.
• Iran started asking for payments for its oil to be in Yen, rather than dollars.
• The sub-prime mortgage crisis will lead to an economic slowdown.

Selling both the Yen and US Dollar has been remarkably successful over the past year, but I’ll leave you with two thoughts: Firstly, all good trends have to end at some point. Technical indicators suggest that most currencies are now very overbought against the Dollar. And secondly, the charts make it look a simple decision, but how many of us leave a trade on for months at a time? My blogs will show it’s very unusual for me to carry a trade overnight; I tend to take my profits or cut my losses and have a good night’s sleep.

Happy trading.